Diamonds: Precious stones, but for who?

Diamonds have long been the object of envy, adorned jewelry decorations and sold at high prices to consumers. But what economic reality hides behind the glittering gloss of these small stones?

What challenges face producing countries if they are to position themselves well in global value chains and so benefit from their natural wealth? To discover this, we must start with an overall analysis of the sector in order to determine where most of the financial benefits are realized.

By nature, the diamond can easily be trafficked secretly giving rise to a black market and strengthening the extractive rationale in producing countries. Moreover, the fact that armed groups used diamonds, among other sources of funding, has provoked discussion. In 2001, a report by the UN panel of experts showed how the diamond trade chain and illicit trafficking in diamonds had fueled armed groups financially. As a result of public pressure, the Kimberley Process (KP) was established; its goal is to stem the flow of conflict diamonds.

Although the objective of the KP is commendable, the existence of smuggling and economic free trade zones seriously undermines its effectiveness. The fact that many transactions are covered by a dark veil across different jurisdictions makes international economic governance indispensable for effectively halting illicit trafficking. At various stages[1] of trafficking there are opportunities for smuggling[2], theft, mixing of uncertified stones with certified ones, and undervaluation by under-reporting of the value and quantity being exported. The last one in particular harms the public finances and hence the economy of the producing countries.

Also, the mixing of illicit and official stones is problematic and this can happen with merchants and in shops and manufacturing centers[3]. Once the diamond is cut and polished, you can no longer tell its origin. Yet there are technologies for tracing and marking the diamond[4]. In addition, the use of complex financial schemes by different players in the sector and related practices such as price transfers to avoid taxes raises questions not only for the finance minister of the countries concerned but also concerning the traceability of these funds.

Smuggling is damaging the Kimberley Process

Diamond smuggling is a loophole both for the KP and for the economic development of the producing countries. There have been various smuggling reports from United Nations official organizations, academic researchers and civil society on the illicit trade in diamonds, the magnitude of which remains difficult to estimate.[5]

For example, the Central African Republic (CAR), a country where the risk of financing armed groups remains high, the level of fraudulent exports is estimated at some 20 to 25%[6] of total production. In 2011, the United Nations Office on Drugs and Crime reported on the various smuggling networks in Africa. For the CAR, diamonds were shipped to international markets through neighbouring Sudan, Chad, Cameroon and the DRC, (the DRC also figured as a transit point for Zimbabwean and Angolan diamonds), although CAR was under a KP export embargo until December 2016. In addition, the illicit trafficking is financed by individuals from countries of destination or trade, such as Belgium, India, Israel, Lebanon, Russia, Switzerland and the United Kingdom.[7] It is worrying that false KP certificates have been discovered in DRC and Cameroon, probably relating to CAR diamonds.[8] Another indication that the problem of conflict diamonds persists is the direct blood-diamond trade between an Antwerp subsidiary Kardiam and its sister company in the Central African Republic, which has financed the Selekas directly. Both companies are subject to United Nations sanctions[9]. As a result, fraudulent traffic undermines efforts of the Kimberley Process and also the economic development of the producing countries.

Beyond Conflict Diamonds
In order to foster a greater contribution from the sector to inclusive development, it is essential to go beyond Kimberley certification and analyze and address underestimation and underreporting in producing countries that constitute a loss for their economies. Underreporting is clearly linked to the willingness of economic actors to reduce local taxes. At the international level, we should also tackle the issue of tax evasion, financial arrangements and money laundering in the sector.[10]

The management of the sector in producing countries in Africa is different. Take the examples of Botswana and the DRC. In terms of volume and value, Botswana is a larger producer than the DRC. At the value level, Botswana exports about 21 million carats while the DRC appears to be around 16 million carats. The big difference lies in the price. Botswana receives $217.5 per carat while the DRC is displayed at $14.62 per carat.[11] The quality of the Congolese diamonds is lower than those of Botswana, but does not justify such a great difference in price.[12] Furthermore, there are considerable management differences between the two countries. In Botswana, it is mainly an industrial affair with the chief company being De Beers[13] and the country has also developed cutting and polishing facilities. At the moment, Botswana faces competition from other countries doing this, particularly India with its centres at Surat and Mumbai where salary costs are lower.[14]

By contrast, the sector in the DRC has not had a stable climate in which to develop. During the years of the second war, diamonds were pillaged, as documented by the UN. In the DRC, most of the diamonds are mined by the artisanal sector (there is one industrial company) and is concentrated on the export of unprocessed diamonds.[15] Nevertheless, the sector’s contribution to public revenue is compromised by the existence of smuggling and under-valuation.[16] In 2006, right after its creation the Centre for Expertise, Evaluation and Certification of precious and semi-precious minerals (CEEC)[17] reported that 40% are probably exported illegally.[18]

To be able to trace the entire export and re-export route of Congolese diamonds more detailed analysis is needed. Confronted with the problem of under-valuation, one can only note the real value of Congolese diamonds when they are exported from their first country of transit or destination, outside the DRC. Nevertheless, at this stage they are already mixed with other diamonds coming from elsewhere or are already cut and polished. In order to determine their true value, the sector must address the issues of traceability and transparency. We’ll come back to that.

Walking alongside artisanal miners

There are different ways of mining and trading and different actors in the artisanal sector and they are paid differently.[19] The artisanal and industrial sectors are diametrically opposite; the former is labour intensive with little capital while the latter is capital-intensive with little hard graft.[20] There is an asymmetry of information and know-how between the artisanal miners and the actors downstream in the value chain. Artisanal miners are not aware of prices internationally, and this compromises their ability to negotiate a good price. There is clear evidence of child labour and harsh living conditions around the mines of Kasai.[21] In addition, the trade done via intermediaries before diamonds reach the market is done in a rather informal way[22] and does not allow the sector to be organised in a more advantageous way for the country; a more formalized sector would allow traders to better position themselves vis-à-vis international traders. To make more profits, it would be important to organize the artisanal and industrial sectors so that they would bring more added value to the country. Similarly, export channels should be better organized so that the state can increase public revenue.

The Diamond Development Initiative has adopted interesting strategies in this regard. In Sierra Leone, the Maendeleo Diamond Standards have been applied with the aim of formalising the artisanal sector by improving socio-economic conditions and promoting sustainable methods. Clearly, the DRC context is different, but this project is a promising exchange of ideas. The DDIs are active in the DRC, particularly with mobile school projects. This is certainly a positive contribution, but, with a budget of $1.3 million, we cannot expect the DDI and partners to upset the multi-billion industrial apple-cart.[23] For this to happen, it would need to enter the added value chain where most profits are to be made.

Upstream in the value chain

Clearly, a country like the DRC does not benefit sufficiently from its natural wealth; currently, there is a shortage of formalisation and of processing activities there; these would allow the country to unleash added value. The added value is created elsewhere. For the DRC, most of the official exports head for the European Union, especially Antwerp, but the significance of the United Arab Emirates has increased significantly from 3% to about 33.3% of exports between 2003 and 2013.[24]

Traditionally, Antwerp has been known as a hub for cutting and polishing diamonds, but recently the trade in unprocessed diamonds has become more important.[25] As for Dubai, apart from its interesting geographical location between the producer countries of the South, the commercial centres of Antwerp[26], London and Tel Aviv and the new centres in the East, Mumbai and Shanghai, it is above all its fiscal advantages that has made this town the 3rd most important diamond centre in the world in a very short time. Dubai offers businesses 50-year tax exemptions and relaxed trade principals. It is particularly interesting as a transit hub where you can re-value and then re-export the diamonds that were originally undervalued, especially diamonds coming from certain African countries such as the DRC.[27] The scale of this practice is overwhelming. After passing through Dubai, the price per carat of rough diamonds explodes by nearly 50% on average, with volumes remaining almost equal. On top of that, in Dubai, Kimberley certificates indicating “mixed origin” are issued, which obscures the origins of diamonds, particularly useful for those who want to operate in the shadows.[28]

Linked to this is the widespread practice of transfer pricing where various related subsidiaries conduct international transactions among themselves in order to avoid taxes. The diamond sector is international in nature and includes companies with subsidiaries around the world, including tax havens, or free trade zones such as Dubai. Via the method of sub-invoicing to subsidiaries in free trade zones like Dubai, diamond businesses in more regulated tax regimes can house profits in these subsidiaries. In addition, the lack of transparency in centers like Dubai is conducive to large transactions. As mentioned, Dubai seems to be the hub for re-exporting rough diamonds.[29]

For the transfer of final profits, there is also the use of numbered accounts listed to the countries with very high banking secrecy such as Switzerland, Luxembourg and Liechtenstein, which makes it impossible to know the real beneficiary. For financial flows for Congolese stones specifically, the Financial Action Task Force (FATF) notes the following: “Belgium has significant financial flows related to money laundering. A trend was noted whereby diamonds and funds formerly flowed from Africa directly to Antwerp; however, more recently both diamonds and funds transit through the United Arab Emirates.”[30]

Besides movements in physical cash from the DRC to Belgium, there had been international transfers to Belgium from the UEA, Hong Kong, China, India, USA and Israel as an element of suspected diamond trafficking. In the other direction 60% of funds were transferred from Belgium to Switzerland and the UAE. This kind of multiple cross-border transactions gives rise to a well-established overlay system[31], sometimes including fictitious exports to modify documents and invoices, which allows specificities of the transactions to be hidden.

The following case of fraud could clarify how a web of corporate structures and illicit activities can extract wealth from Africa. The case of Omega Diamonds links diamonds from the Central African countries, Angola, DRC and Zimbabwe, to the United Arab Emirates (UAE) and Antwerp. Originally diamonds were bought at ridiculously low prices in African countries. Then, they left the producing country for a company based in Dubai where certificates of mixed origin and a new invoice with a boosted value of 20 to 31% were added, allowing companies to maximise profits in Dubai by “optimizing” taxes. Then the diamonds were sold on the Antwerp stock exchange and the profits transferred to accounts in Switzerland.[32] Belgian customs had estimated the fraud at € 2 billion, but thanks to a new law just established[33], Omega was able to settle this case for € 160 million.

There is a further security concern if, as according to the FATF and the EGMONT group “Diamond trade centres like Dubai, which operate as Free Trade Zones are susceptible to vulnerabilities as specified in the FATF report regarding the Money Laundering vulnerabilities of Free Trade Zones. This, in combination with the specific vulnerabilities of the diamond trade and the mechanism of transfer pricing, creates a significant vulnerability for Money Laundering and Terrorist finance activities.”[34] Therefore, the above method can also be used for money laundering and financing terrorists.

Conclusion

In addition to the need to strengthen the artisanal sector and to promote processing activities in producing countries, it is essential to address issues of price transfers, undervaluation, bad governance and tax evasion. According to the UN Economic Commission for Africa, the continent is losing around $ 50 billion due to illicit financial flows that are caused by the above practices.

The analysis above shows that an exchange of information between key countries (trading centres, transit countries and producing countries) is desirable to combat international fraud. First, existing initiatives such as the Extractive Industries Transparency Initiative could be strengthened. The UAE, India and China and several companies in the sector are not members of this Initiative. If such a voluntary initiative does not produce results for producer countries, they can push for mandatory reporting in the extractive sector through the so-called “mandatory country-by-country and project-by-project reporting. ”

This will also increase transparency in the sector, which could help prevent money from ending up with criminal networks, or even become a security issue by financing terrorist networks. Thus, countries can put the profits towards inclusive development and put countries on the path to diversification of economic activities.

Gino Brunswijck

[1] The stages in the trade of stones: cutting and polishing, trade in polished stones and wholesale and retail sales (Unodoc)